Vattenfall AB. Update to credit analysis. CREDIT OPINION 12 January Update

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1 CREDIT OPINION Vattenfall AB Update to credit analysis Update Summary Vattenfall AB (Vattenfall) s credit quality is supported by (1) the company s breadth and scale of operations; (2) the clean generation portfolio in the Nordics, albeit making a declining contribution to profitability; (3) the relatively stable and predictable cash flows generated by its electricity distribution and district heating activities; and (4) the increasing contribution from contracted renewables and the company s growing expertise in offshore wind development. RATINGS Vattenfall AB Domicile Sweden Long Term Rating A3 Type LT Issuer Rating Outlook Stable Please see the ratings section at the end of this report for more information. The ratings and outlook shown reflect information as of the publication date. Contacts Joanna Fic VP-Sr Credit Officer joanna.fic@moodys.com These factors are balanced by (1) Vattenfall's exposure to conventional power generation, which accounted for around 40% of EBITDA in 2016; (2) the negative effect of low power prices on the company s financial profile, although this is partially offset by cuts in Swedish nuclear and hydro taxes; and (3) the execution risk associated with Vattenfall s strategy to grow its renewable energy portfolio and adapt to the evolving industry of energy services. From a financial risk perspective, we expect Vattenfall's ratios to improve starting from 2019 as the company's investments in renewables and distribution networks translate into growth in earnings, which we expect to more than offset a decline in the generation segment. Exhibit 1 Vattenfall s financial metrics are expected to strengthen post-2018 adjusted FFO in SEK billion Neil Griffiths Lambeth Associate Managing Director neil.griffiths-lambeth@moodys.com CLIENT SERVICES Americas Asia Pacific Japan EMEA The estimates represent Moody's forward view; not the view of the issuer. Source: Moody's Investors Service The A3 rating incorporates a one-notch uplift for potential support given the 100% ownership by the Government of Sweden (Aaa stable).

2 Credit Strengths» Predominantly clean generation mix in the Nordic region» Phasing out of nuclear tax and a reduction in hydro tax in Sweden will support profitability of conventional generation» Solid earnings contribution from low-risk regulated and contracted businesses» Supportive stance of government of Sweden in relation to dividends Credit Challenges» Low power prices exert pressure on conventional generation earnings» Large capex programme carries some execution risk» Increasingly competitive environment for new renewable assets Rating Outlook The stable outlook reflects our expectation that (1) Vattenfall will be able to maintain financial metrics in line with the guidance for the current rating, which includes funds from operations (FFO)/net debt approaching 20% and retained cash flow (RCF)/net debt approaching 15%, and (2) the company will deliver on its strategy of shifting its business risk profile to lower risk activities. Factors that Could Lead to an Upgrade Upward pressure on Vattenfall s ratings is unlikely in the medium term given the still challenging power price environment and considering the execution risks associated with delivery of the company s strategy. Factors that Could Lead to a Downgrade The ratings could be downgraded if (1) credit metrics appear likely to fall below our guidance for the A3 rating, and/or (2) delivery of Vattenfall s strategy assuming an increase in regulated and contracted cash flows was challenged. This could be due to, for example, delays and/or cost overruns in offshore wind development. A change in the government support assumption could also result in a downgrade of Vattenfall s ratings. Key Indicators Exhibit 2 Vattenfall AB 12/31/ /31/ /31/ x 5.7x 5.6x 4.9x (CFO Pre-W/C) / Net Debt 19.1% 22.6% 21.0% 20.6% RCF / Net Debt 18.1% 22.0% 20.7% 15.7% (CFO Pre-W/C + Interest) / Interest 12/31/2013 [1] All ratios are based on 'Adjusted' financial data and incorporate Moody's Global Standard Adjustments for Non-Financial Corporations. Source: Moody's Financial Metrics. Note: For definitions of Moody's most common ratio terms please see the accompanying User's Guide. Profile Vattenfall AB is a 100% Swedish state-owned company. With 31 gigawatts (GW) in installed capacity and 119 TWh in electricity output, Vattenfall is one of the biggest European energy groups. The company s generation portfolio primarily includes hydro (8.8 GW) and nuclear power (7.3 GW) in the Nordic region, as well as coal and gas in Germany and the Netherlands. Vattenfall has also 11 GW in installed capacity in heat, mainly in Germany, Sweden and the Netherlands. This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on for the most updated credit rating action information and rating history. 2

3 In addition to power and heat generation, Vattenfall owns Sweden's second largest electricity distribution network and the electricity distribution grid in Berlin. The company's retail base includes 6.3 million of electricity customers and 2.2 million of gas customers. Exhibit 3 Exhibit 4 Vattenfall has a diversified business mix... but derives majority of its earnings from its domestic market Underlying EBITDA breakdown, in 2016 Underlying operating profit breakdown, in 2016 Customers& Solutions 8% Nertherlands 6% Heat 19% Other 1% Power Generation 40% Germany 35% Sweden 57% Distribution 21% Wind 12% Note: Total underlying EBITDA of SEK36 billion. Source: Company, Moody's Investors Service Note: Total underlying operating profit of SEK22 billion. Source: Company, Moody's Investors Service Detailed Credit Considerations Strategic focus on shift toward clean energy With the divestment of lignite operations in Germany in September 2016, Vattenfall has reinforced its strategic focus on shifting its portfolio toward clean energy. To support its strategy, the company plans investments of SEK50 billion in Some SEK28 billion of the total is earmarked for growth capital expenditure (capex), primarily on expansion in onshore and offshore wind (SEK17 billion). Vattenfall has not provided a target for capex over the medium term. However, given the company's pipeline of offshore wind projects and focus on efficiency improvement of its existing assets, we expect the majority of investments to continue to be directed into growing wind capacity and regulated networks. Given this strategy and continued pressure on profitability of merchant power generation, we expect Vattenfall's business mix to shift. We estimate that the company will derive 60-65% of its earnings from regulated, quasi-regulated and contracted cash flows by Exhibit 5 Vattenfall s business mix shifts towards more regulated and contracted cash flows Underlying EBITDA, in SEK billion Power Generation Wind Distribution Heat Customer& Solutions Other % 20 45% 40% E 2020E The estimates represent Moody's forward view; not the view of the issuer. Source: Company, Moody s Investors Service 3

4 Fixed-cost generation under pressure from low power prices With 69% of 2016 output represented by nuclear and hydro, Vattenfall's generation fleet is predominantly fixed-cost in nature, making the company particularly exposed to prevailing wholesale power prices. This was evidenced in 2016 when power generation EBITDA was down by over 9% year-on-year, to SEK14.4 billion. Exhibit 6 Exhibit 7 Majority of Vattenfall's portfolio is based on clean generation......and in the Nordics Breakdown of electricity output by fuel, in 2016 Breakdown of electricity output by region, in 2016 Gas 11% Wind 5% Other 1% UK 2% Netherlands 13% Nuclear 39% Germany 17% Hard coal 14% Other Nordics 1% Sweden 67% Hydro 29% Note: On a fully consolidated basis. Source: Company, Moody's Investors Service Note: On a fully consolidated basis. Source: Company, Moody's Investors Service We expect power prices in the Nordics to remain in a range of 23-29/MWh until This reflects our expectation of (1) weak commodity prices; (2) a reduction in the Nordic capacity surplus from 2020 due to increased (realisable) export capacity from new interconnectors to Europe; and (3) a gradual increase in CO2 prices from (See Europe's electricity markets: In the Nordics, reduced capacity from 2020 will raise power prices from low levels, November 2017). The operating conditions will also remain challenging in Germany, where the market will remain structurally oversupplied to the early 2020s as new renewable capacity will more than offset thermal and nuclear closures, maintaining pressure on power prices and adding to volatility. (See Europe's electricity markets: In Germany, renewables growth pressures prices, mitigated by plant closures, November 2017). The impact of changes in wholesale power prices on Vattenfall will be limited in the near term by price hedges. The company has hedged 69% and 51% of its Nordic output at the average price of 27-28/MWh in 2018 and 2019 respectively. Vattenfall has also hedged 19% of its 2020 output at 32/MWh. Given low power price environment, Vattenfall s profitability will continue to be under pressure, albeit this will be somewhat offset by the cuts in nuclear and hydro taxes in Sweden. although cuts in nuclear and hydro taxes provide some relief In 2016 the Swedish government decided to phase out the nuclear capacity tax and cut hydro real estate taxes in order to support the country s path to free-carbon generation and promote low carbon investments. Nuclear capacity tax of SEK70/MWh was cut by 90% from 1 July 2017 and abolished from 1 January 2018, resulting in expected annual savings to Vattenfall of around SEK3 billion. The cuts to hydro real estate tax, which amounted to SEK85/MWh, will be gradually implemented over the period (a tax rate will decline from 2.8% to 0.5% over the period). In addition to the decrease in the hydro tax rate, the hydropower real estate values, which are linked to electricity prices, will be updated in 2019 resulting in a lower tax base. The cuts in taxes are positive for Vattenfall as they will result in annual savings of around SEK5 billion in total. However, whilst hydro power plants are cost competitive, improving profitability of the nuclear plants will depend on Vattenfall's ability to deliver on its cost reduction plan given the relatively high cost of production (SEK250/MWh, excluding capacity tax). We consider that there is some uncertainty around the scope of cost reductions, although we positively note that Vattenfall's nuclear plants have relatively modest investment requirements, including due to more stringent safety requirements. The positive impact of cuts in nuclear capacity taxes on Vattenfall's profitability will be tempered by an increase in the nuclear waste fee to SEK50/MWh from SEK40/MWh (on average) for the period, although the higher fees will directly contribute to the Swedish nuclear waste fund, ultimately payable back to the nuclear operators. 4

5 Overall, we expect Vattenfall's EBITDA from power generation to stabilise from this year, following a decline in 2017, as lower taxes will support plants' profitability. Renewables growth will boost long-term contracted cash flows Vattenfall s installed capacity in renewables, excluding hydro, amounts to around 2.8 GW, of which 1.6 GW is offshore wind. The company's portfolio of renewables is spread over five European countries (Denmark, Sweden, Germany, UK and the Netherlands), with the UK accounting for around a third of the installed capacity. We estimate that Germany accounts for the bulk of earnings. The renewable assets benefit from support schemes, which provide a degree of earnings stability and insulate Vattenfall from wholesale power price volatility. The company s merchant power price exposure in renewables is mainly related to wind farms, for which the subsidy period has expired, the Swedish wind farms under the certificate scheme and the UK wind farm projects under the renewable obligation certificates (ROC) scheme. We estimate that over 80% of Vattenfall's revenues is, however, generated from the sale of power based on fixed tariffs, with a remaining subsidy-based contract life of around 10 years. Although renewable subsidies provide lower risk cash flows than merchant generation, wind farms are subject to output variability dependent on wind conditions. Moreover, we consider that offshore wind development carries material execution risks. This is only somewhat mitigated by Vattenfall's growing experience and track record of project delivery. Vattenfall's pipeline of investments includes three offshore wind farms in Denmark, which will result in a meaningful step up in the company's renewable capacity and associated earnings. We expect the contribution of EBITDA from renewables to increase to some 25-30% assuming successful delivery of Vattenfall's strategic renewable target that would bring installed capacity to 4.5 GW by Exhibit 8 Offshore wind accounts for the bulk of Vattenfall s investments in renewables Major projects completed in 2017 or due for completion until 2021 Sandbank Pen y Cymoedd Aberdeen Bay Horns Rev 3 Near Shore Type Offshore Onshore Offshore Offshore Offshore Kriegers Flak Offshore Country Germany UK UK Denmark Denmark Denmark Capacity 288 MW 228 MW 92 MW 407 MW 350 MW 600 MW Completion Q Q e 2019e 2020e 2021e Subsidy regime Subsidy level End of subsidy period Feed-in-tariff ROC ROC Feed-in-tariff Feed-in-tariff Feed-in-tariff 194/154/MWh 0.9 ROC 2.5 ROC 103.1/MWh DKK475/MWh 49.9/MWh 2023/ e 2031e 2032e Note: The end of subsidy period for Danish offshore wind projects depends on the number of hours. Source: Company and other, Moody s Investors Service The long-term contracted cash flows under supportive and well-established regulatory regimes underpin Vattenfall s credit quality. Whilst we see a potential shift towards increasingly merchant power exposure as a longer term risk for the industry, as evidenced in the German auction zero-subsidy bid results in April 2017 and Vattenfall's participation in the Dutch tender Hollandse Kust Zuid in December 2017, we currently expect the company's exposure to merchant power to remain relatively unchanged until mid-2020s. Moderate contribution from electricity distribution networks in stable regimes Vattenfall is the second largest electricity distribution network owner and operator in Sweden. The company also owns and operates a network in Germany (Berlin). Its distribution grids cover around 3.3 million customers. We view the regulatory frameworks for electricity distribution networks in Sweden and Germany to be well-defined and generally supportive of Vattenfall s credit quality. Revenues are underpinned by regulatory mechanisms designed to provide adequate and fair remuneration for operating expenditure and investments. The current regulatory period in Sweden spans The level of remuneration for this four-year regulatory period was appealed in court, with the court ruling in December 2016 on the weighted average cost of capital (WACC) of 5.85%. This return was appealed by both the company and the Swedish Energy Markets Inspectorate, but was rejected by the administrative court of appeal. This means 5

6 that the above return will be effective until the end of the current regulatory period. Overall, we expect earnings to increase on the back of a growing asset base and recoveries from the previous regulatory period. Post-2019, we expect, however, a reduction in the allowed return, which will drive a modest reduction in Swedish electricity distribution earnings. In Germany, the current regulatory period for distribution networks spans , providing some certainty of cash flows over the remainder of the period. The regime is well defined, although some regulatory principles are still evolving. The allowed equity returns of 9.05% (or 7.14% for assets built before 2006) for the current period are higher than in most other jurisdictions. However, the allowed equity return will reduce to 6.91% (or 5.12% for pre-2006 assets) for the third regulatory period We also expect increased efficiency challenges, with the regulator yet to determine company-specific and sector-wide targets. District heating activities add to diversification and cash flow stability Heat sales account for over 80% of this segment s revenue. The remainder is generated from sales of electricity as a by-product from Vattenfall's CHP plants. Vattenfall is one of Europe s largest producers and distributors of heat, supplying electricity and heat to growing metropolitan areas in Northwest Europe, including Berlin, Hamburg, Amsterdam and Uppsala. The German market accounts for the majority of Vattenfall's heat sales TWh out of 20.3 TWh (69%) in total in District heating is not a regulated business, but it generates fairly stable cash flow, given the high barriers to entry and/or long-term heat contracts. In Germany, a typical length of the contract is 10 years. This compares with year concessions in the Netherlands. In contrast, in Sweden, contracts are short-term, but the company benefits from a strong market position with very low churn rates (less than 1%). Whilst heat activities are profitable and fairly stable, subject to changes in volumes dependent on weather and cost of fuel, we expect EBITDA from this segment to be pressured over the near term as condensing power plants, which are fully exposed to wholesale market prices, will continue to be challenged by tight spreads. In this regard we note that a conversion of the Moorburg coal-fired condensing plant into a CHP plant completed last year should result in improved margins going forward. Retail segment provides a strong platform for development of energy solutions Vattenfall is a large supplier of electricity and gas, with 2016 sales of 89 TWh and 53 TWh respectively, serving 8 million customers. The company has a leading market position for supply of electricity and gas to households and business customers in the Netherlands (3.7 million contracts). In Germany, where Vattenfall has some 3 million retail customers, the company has a leading position in the cities of Berlin and Hamburg. Generally we consider retail earnings of lower quality than Vattenfall's other segments and the company is exposed to the risks of declining consumption and margins. Nonetheless, the business is in a strong position to benefit from demand growth as well as from the cross-selling of new solutions in a changing world of energy services. Externalisation of German nuclear obligations has reduced the risk Following the payment of around SEK17.2 billion, of which SEK4.7 billion related to the risk premium required for the externalisation of the liabilities, on 3 July 2017, risks related to Vattenfall's nuclear obligations in Germany have been reduced. The company's obligations are now mainly related to dismantling of the plants and packaging of the low- and medium-level waste before it is handed over to interim and final storage. The removal of nuclear fuel was completed for Brunsbüttel nuclear reactor in The de-fueling process for Krümmel nuclear reactor is planned for this year. We note that Vattenfall is pursuing a case at the Washington-based International Centre for Settlement of Investment Disputes concerning the financial losses caused by the early withdrawal of the operational permits for its German nuclear power plants - a decision made by the German government in the aftermath of the Fukushima disaster in Japan in We understand that the case is supported by the German Federal Constitutional Court ruling from December 2016, when the court stated that a foreign and stateowned company had rights to compensation in relation to the thirteenth amendment to the Nuclear Energy Act. The company's claim amounts to 4.4 billion (excluding interest), although there is uncertainty regarding the timing of the decision and any potential benefit to Vattenfall. 6

7 Financial ratios are weakly positioned against our guidance but expected to improve over the medium term Vattenfall's reported EBITDA increased by 2% to SEK24.4 billion in 9M The improvement in earnings was mainly driven by higher availability of nuclear plants, which was somewhat offset by lower hydro power production, an increase in renewable capacity, better margins in the heat segment and higher regulated network tariffs. The earnings also benefitted from a tax refund related to the German nuclear fuel tax, which had a positive impact of SEK1.8 billion. (See German Utilities: Nuclear fuel tax court ruling positive for utilities, June 2017). Notwithstanding the above, we expect Vattenfall's financial ratios in to be weakly positioned against our guidance for the current rating, which includes FFO/net debt approaching 20% and RCF/net debt approaching 15%. Nevertheless, the A3 rating factors in the expected improvement in Vattenfall's credit metrics as the company's investments in renewables and regulated distribution networks translate into growth in earnings, which will more than offset a decline in the power generation segment. We note that our current ratio guidance is consistent with a risk profile where the contribution from merchant generation is around or below 30% of EBITDA. Should this business activity represent a higher contribution to earnings, due to, for example, materially higher power prices, then the guidance would likely be higher, reflecting the more volatile profile of these cash flows. We positively factor Vattenfall's commitment to maintain a strong credit profile. The company's financial targets include FFO/adjusted net debt of 22-27% and dividend policy, which assumes a pay-out ratio of 40-70% of the consolidated net income. See Vattenfall AB: Credit quality unaffected by the revision of financial targets, 21 November Government ownership provides a rating uplift Given the 100% ownership by the Swedish government (Aaa stable), Vattenfall is considered a Government-Related Issuer (GRI) under Moody's methodology. Vattenfall's A3 rating factors in one notch of uplift from the company's baseline credit assessment (BCA) of baa1. Whilst we recognise the strategic importance of the company within Sweden, we also acknowledge the state's determinedly non-interventionist stance. We believe that the authorities would hesitate to intervene (such as through a direct capital injection) except in the most extreme circumstances, i.e. where there is a threat to key strategic Swedish assets such as key nuclear and hydrological generating assets, and its network infrastructure. The government has nonetheless been supportive towards Vattenfall with regard to its dividend policy. It also supports the company's low CO2 policy, which was in keeping with the recent disposal of its lignite assets. Moderate risk from decarbonisation of the power sector The EU has committed to reduce greenhouse gas emissions by 40% from 1990 levels and to increase the contribution of renewables to energy demand to 27% by These targets, agreed in 2014, formed the basis of the EU's Nationally Determined Contributions incorporated into the Paris Agreement, and are designed to significantly decarbonise the region's economies. We believe that unregulated utilities, which account for 40% of EU carbon emissions, will need to deliver a significant share of the reductions, and that this will create a variety of risks and opportunities for individual utilities. We believe that Vattenfall is moderately well-positioned to face carbon transition risks compared to peers given fairly low-carbon intensity of its fleet (170 g/kwh in 2016), as well as the growing contribution of renewables and regulated activities to its earnings. This is mitigated by its large exposure to large-scale, centralized generation. Moody's framework for assessing the risk associated with decarbonisation in this industry is set out in Carbon Transition Brings Risks and Opportunities for Unregulated Utilities published in October Liquidity Analysis As of end-september 2017, Vattenfall s liquidity position was supported by (1) SEK34 billion of cash and short term investments, and (2) a committed Revolving Credit Facility (RCF) of 2 billion (SEK20 billion). The RCF, which is fully undrawn, expires in December

8 Exhibit 9 Vattenfall has a fairly well-spread debt maturity profile as of end-september 2017, in SEK billion Senior unsecured Undrawn RCF Hybrids Note: Maturity of hybrids shown at call dates. Source: Company, Moody's Investors Service Structural Considerations Vattenfall's capital structure includes a mix of senior unsecured bonds, bank debt and hybrid securities. As of end-september 2017, Vattenfall had four hybrids outstanding: 1 billion due March 2077, SEK3 billion due March 2077, SEK3 billion due March 2077 and $400 million due November The 2 long-term rating on the hybrid securities is two notches below the senior unsecured rating, which reflects the features of the hybrids that receive basket C treatment, i.e. we treat them as 50% debt and 50% equity for financial leverage calculations. Rating Methodology and Scorecard Factors Vattenfall is rated in accordance with the rating methodology for Unregulated Utilities and Unregulated Power Companies, published in May 2017, and Government-Related Issuers, published in August

9 Exhibit 10 Rating Factors Vattenfall AB Moody's Month Forward View As of Jan 2018 [3] Current LTM 9/30/2017 Unregulated Utilities and Unregulated Power Companies Industry Grid [1][2] Factor 1 : Scale (10%) Measure Score Measure Score A A A A a) Market Diversification b) Hedging and Integration Impact on Cash Flow Predictability c) Market Framework & Positioning Ba Ba Ba Ba d) Capital Requirements and Operational Performance e) Business Mix Impact on Cash Flow Predictability Aa Aa Aa Aa a) Scale (USD Billion) Factor 2 : Business Profile (40%) Factor 3 : Financial Policy (10%) a) Financial Policy Factor 4 : Leverage and Coverage (40%) a) (CFO Pre-W/C + Interest) / Interest (3 Year Avg) 5.5x 5x - 6x b) (CFO Pre-W/C) / Net Debt (3 Year Avg) 22.9% 19% - 21% c) RCF / Net Debt (3 Year Avg) 22.0% 14% - 15% Ba/ Rating: a) Indicated Rating from Grid 1 b) Actual BCA Assigned baa1 Government-Related Issuer 2/1 Factor a) Baseline Credit Assessment baa1 b) Government Local Currency Rating Aaa c) Default Dependence Moderate d) Support Moderate e) Final Rating Outcome A3 [1] All ratios are based on 'Adjusted' financial data and incorporate Moody's Global Standard Adjustments for Non-Financial Corporations. [2] As of 9/30/2017(L); Source: Moody's Financial Metrics [3] This represents Moody's forward view; not the view of the issuer; and unless noted in the text, does not incorporate significant acquisitions and divestitures Source: Moody's Investors Service Ratings Exhibit 11 Category VATTENFALL AB Outlook Issuer Rating Senior Unsecured Subordinate MTN Jr Subordinate Commercial Paper Moody's Rating Stable A3 A3 (P)1 2 P-2 Source: Moody's Investors Service 9

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